A complete guide to the types of inventory

How you manage your inventory can either make or break your operations.

What’s more, the complexity of dealing with your inventory grows dramatically with every additional product or product variant you add to your catalog. Hence, it is worthwhile to understand fundamental questions related to inventory and inventory management — exactly what this guide covers.

We’ll define what inventory is and explain the different types you will encounter in your business ⁠— to support these definitions, we’ll look at the fictional Acme Corporation of Warner Bros fame and the different types of inventory they hold.

What is inventory?

Inventory is the sum of all items intended to be sold by your business. 

This constitutes a strict definition and only includes everything from your raw materials to finished goods that will eventually end up in your customers’ hands.

While this definition is of the most practical importance, it is useful to expand our definition a little bit to include materials and goods that are essential to your production process. This expansion allows the inclusion of materials that will never reach your customers but are vital for your business and hence should be part of your inventory.

Ultimately, inventory is the sum total of all the goods and materials that your business holds for either resale, production, or utilization.

When your business is small, you often don’t even need to think about inventory management. However, as your business grows, so does your inventory and the need to manage it efficiently. Inventory management systems evolve along the following lines in general:

• Mental notes and intuition
• Simple paper-based solutions (Sticky notes, notepads, etc.)
• Excel-based management
• Dedicated inventory management software 

Each step improves on the previous ones and attempts to equip you with the best tools to tame the complexity of managing your workflows and inventory. Of course, your business could have already grown to the point where you’d have to skip a step or two to use manufacturing software with built-in inventory management features.

However, let’s return to the task of classifying inventory.

What are the types of inventory?

Inventory is generally classified into a handful of key types. Knowing which items belong to which category makes it easier to manage your operations and keep track of what you hold at each stage of the business.

Here’s what each type consists of and what to keep in mind when managing it.

Raw materials

Raw materials are all the items that your business uses to manufacture finished products. 

These materials can be sourced, produced by your company, or procured from a supplier. Raw materials can be further classified into two categories: 

• Direct raw materials 
• Indirect raw materials

Direct raw materials

Direct raw materials are the components that are used directly in the final product. These materials are easy to quantify and account for per unit or per batch basis. 

Indirect raw materials

Indirect raw materials are the components that are not part of the final products but are used during the production process. Indirect raw materials are harder to identify and account for since they can’t be traced to specific batches or units. However, these are essential for the production process.

For instance, one of Acme Corp’s top-selling products is its Plush Couch 5000. To manufacture each Plush Couch 5000, Acme Corp requires high-quality metal frames, foam, and leather as raw materials. However, the main component of the Plush Couch 5000 happens to be one ridiculously large spring that can shoot your target to the stratosphere. These are the components that it can easily quantify and price. 

So Acme categorizes these as its direct raw materials.

Of course, making a couch isn’t as simple as throwing foam and leather on top of a frame. The company also requires tools, screws, glue, staples, and leather wax to manufacture the couches. However, it is pretty hard to quantify how much leather wax or how many staples are used on each couch. 

So these raw materials are categorized as indirect raw materials.

Work-in-progress (WIP)

All the materials that your factory floor has started working on, but the product isn’t quite finished yet, consist of your work-in-progress (WIP) inventory. 

It can comprise direct and indirect raw materials — the only thing to note here is that the product is not complete and is a work in progress.

Continuing with the Acme Corp example, let’s assume that every couch has a production time of one week. So once the metal frames, foam, and leather have been cut to size and work on a couch has begun, those materials stop being part of the raw materials and should be considered WIP inventory.

Finished goods

All the items ready to be sold are considered part of your finished goods inventory.

Of course, depending on the workflow you adopt, this could mean slightly different things. 

If you follow a make-to-order workflow, then the final product is made and can already be shipped to your customers. Whereas, if you follow the make-to-stock workflow, the inventory will have to be stored in a warehouse until an order comes through. In either case, your finished goods inventory should be pretty clear and straightforward to account for and track.

In the case of Acme Corp, once the couches are ready, they are stored in a warehouse until a shipping company picks them up and delivers them to customers. The finished couches are part of Acme’s finished goods inventory.

Maintenance, Repair, Operations (MRO)

As the name suggests, maintenance, repair, and operations (MRO) inventory is essential to keep your factory operational. MRO inventory is strictly for your consumption and is not available for customers to purchase.

For example, Acme Corp maintains clean and safe working environments for its employees. Cleaning supplies and equipment used by the facilities team — vacuum cleaners, cleaning products — are part of the MRO inventory. So are the tools and spare parts needed to repair broken machinery.

Safety stock

Safety stock is the reserve inventory a business keeps above what it expects to need – a buffer for when demand spikes, a supplier runs late, or something in the supply chain doesn’t go to plan.

How much safety stock makes sense depends on how predictable your demand is and how reliable your suppliers are. A business with steady, foreseeable sales and a consistent supplier can get by with a smaller buffer. A business selling across multiple channels – where a promotion or a viral post can drain stock faster than a reorder can arrive – generally needs more.

Safety stock typically sits within your finished goods or raw materials inventory rather than as a separate category. The distinction is in why it’s being held: it’s the stock you’re keeping as a contingency, not stock you expect to sell through in the normal course of business.

Dead stock

Dead stock is inventory that has stopped selling and is unlikely to move at full price. It ties up warehouse space and working capital without generating any return. The longer it sits, the more it costs.

Tracking sell-through rates by product is the most reliable way to stay on top of it. Catching slow-moving inventory early means you still have options, like a promotion or a clearance sale, before the problem gets worse.

For strategies to identify and clear dead stock before it compounds, see our dead stock guide.

Inventory management

With the classification of inventories down, the natural question that arises is how to manage them effectively.

There are plenty of strategies when it comes to managing your inventory. However, it is becoming increasingly easy to implement perpetual inventory systems with the rise of inventory management software like Katana.

A perpetual inventory management system automatically maintains inventory counts through live systems that record and account for sales and orders in real time. This greatly simplifies maintaining stock by drastically reducing the need to perform expensive inventory audits.

For instance, Katana’s live inventory management features let you track stock across multiple warehouses and locations and keep all your teams on the same page. Try Katana free for 14 days.

A breakdown of the key points of the types of inventory

To recap what you’ve learned, here is a short summary of the key points from the guide.

Inventory: The total of all the goods and materials your business holds for resale, production, or utilization. 

The main types of inventory are:

• Raw materials (direct materials and indirect materials)
• Work-in-progress (WIP)
• Finished goods
• Maintenance, Repair, Operations (MRO)
• Safety stock
• Dead stock

For your business to be successful and efficient, it is important to manage inventories well.

Perpetual inventory management systems provide many benefits, and implementing them is getting increasingly easy due to cloud systems like Katana.

And there we have it: everything you need to know about the types of inventory and how to use them in your business.